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Global Tensions and Economic Security. 2015 CCMR Executive Course in Decision Making Naval Postgraduate School May 13, 2015 Dr. Robert E. Looney relooney@nps.edu. Outline. The Global Economic Crisis and Aftermath Overview Patterns of Recovery The Current Situation Forecasts/Scenarios
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Global Tensions and Economic Security 2015 CCMR Executive Course in Decision Making Naval Postgraduate School May 13, 2015 Dr. Robert E. Looney relooney@nps.edu
Outline • The Global Economic Crisis and Aftermath • Overview • Patterns of Recovery • The Current Situation • Forecasts/Scenarios • Key Risks • Eurozone Crisis -- Financial market instability • Instability in Oil Exporting Countries • African Debt – Increased vulnerabilities • China Hard Landing – Instability in the global economy • Falling Defense Expenditures in the West – Declining world security • General Lessons
Economic Crisis and Security Threats “The global recession is America’s primary near-term security concern.” Admiral Blair – Director of National Intelligence (February 2009) “The single biggest threat to national security is the national debt.” Admiral Mullen, Chairman of the Joint Chiefs of Staff (August 2010) “I have to confess, I paid no attention to this (economics) as a cadet and have done nothing to increase my awareness of economics issues between age 22 and 59. I should have paid attention.” General Dempsey, Chairman of the Joint Chiefs of Staff (October 2011)
Global Economy Overview I The Changing Global System • Before the 2008-09 crisis, the main feature of the global economy was its rapid integration – has continued but at a slower pace since the crisis • However, economic policies largely set at the national level to benefit domestic economy • These policies are increasingly affecting other economies • External effects are particularly important in the financial sector due to potential for large and abrupt changes in: • Capital flows • Asset prices • Interest rates, exchange rates, and • Credit availability.
Global Economy Overview II The 2008-09 global economic crisis and its aftermath illustrate this new reality • Characterized by defective growth models in advanced economies based on • Excess monetary expansion/credit and • Debt-driven domestic aggregate demand • Complicated by structural flaws and limited adjustment mechanisms especially in Europe leading to • Instability • An on-going crisis • Large negative shock to the real economy • Emerging economies were subsequently affected by • Credit tightening (including trade finance) • Rapid declines in exports
Global Economy Overview III • Post-crisis policy largely based on credit expansion and debt reduction • Unconventional monetary policy – United States • Lowered cost of credit for debtors and those seeking to borrow for business expansion • Came at the at expense of savers – lower interest rates • Did not work well because investment constrained by deficient domestic demand relative to capacity • Savers sought higher returns in emerging economies • Causing increases in credit and causing upward pressure on exchange rates and asset prices – responded with • Limits on capital inflows • Reserve accumulation and • Measures to restrict credit and restrain asset-price inflation
Global Economy Overview IV • Situation changed in May 2013 when U.S. Federal reserve indicated it might taper its purchase of long-term assets • Asset prices shifted and in emerging economies • Capital rushed out, • Caused credit markets to tighten and • Exchange rates to fall • Causing a slowdown in short-term growth. • The reversals may have longer term adverse effects – although not clear at this point • While China’s output is affected by advanced country economic performance – financial system largely isolated • Capital account less open, foreign currency reserves of $2.5 trillion mean exchange rate is controllable
Global Economy Overview V • Decentralized policy and growing externalities will result in a partial de-globalization • Not a good idea to run persistent current account deficits and become dependent on (temporarily) low-cost foreign capital • Open capital accounts may be replaced by rules-based constraints on financial capital flows • Lesson from crisis • Pattern of accumulating reserves via current account surplus will be more pronounced in order to manage exchange rates • Public purchases of domestic assets to stabilize asset prices net capital flows will become increasingly common. • Successful countries will be those who learn to live with growing policy interdependency without much policy coordination
Patterns of Recovery from The Crisis I Patterns of Recovery • Differences in GDP levels and growth rates since the beginning of the crisis strikingly diverse: • Far exceed differences in economic performance observed prior to the crisis. • Even within Europe and within the euro area. • Can assign countries to groups based on the depth of the initial output loss and the gap between pre-crisis and post-crisis growth. • The cumulative output loss during the crisis is • The sum of the gap between 2008 and 2007 GDP, • Plus the gap between 2009 and 2007 GDP, expressed in percentage points of 2007 GDP.
Patterns of Recovery from The Crisis II • Countries were allocated to the following groups: • Real GDP level lower in 2009 than in 2007 and projected to be lower in 2016 than in 2009. Croatia, Greece, Italy, Portugal. • Cumulative output loss during the crisis smaller than 4% of GDP, and annual post-crisis real GDP growth (2009–16) more than half the pre-crisis (2000-2007) rate. Belgium, Canada, France, Norway, Switzerland, United States. • Cumulative output loss during the crisis between 4 and 8% percentage points of GDP and annual post-crisis growth more than half the pre-crisis rate. Austria, Denmark, Germany, Japan, Sweden, United Kingdom.
Patterns of Recovery from The Crisis III • Groups (contd.) • Cumulative output loss during the crisis between 4 and 8 percentage points of GDP and annual post-crisis growth less than half the pre-crisis rate. Czech Republic, Netherlands, Serbia, Spain. • Cumulative output loss during the crisis more than 8 percentage points of GDP and annual post-crisis growth more than half the pre-crisis rate. Estonia, Hungary, Ireland, Lithuania. • Cumulative output loss during the crisis more than 8 percentage points of GDP and annual post-crisis growth less than half the pre-crisis rate. Bulgaria, Finland, Latvia, Romania, Slovenia.
Current Global Situation I • Six years after the 2008-09 crisis, economic performance still disappoints, failing to regain pre-crisis vitality • Emerging economies far from the dynamic miracles they once seemed • Rich countries still grappling with problems exposed by the crisis • Return to days of buoyant growth seems far away • Level of dissatisfaction summed up at September 2014 G-20 meeting – their summary statement: • “Growth in the global economy is uneven and remains below the pace required to adequately generate much needed jobs.” • Worse -- they saw new threats in financial markets and deteriorating geopolitics • Little unity among the member countries who account for 85% of world output
Current Global Situation IV • Although the global picture is disappointing there are signs of optimism along with underperformance: • The growth surge in the in the UK along side economic weakness in France • Recent optimism in India together with the disappointing performance of Russia and Brazil exposing their weaknesses. • Across the world recovery can not be easily characterized as V-shaped or L-shaped • Instead OECD feels there is a “growing degree of divergence between the major economies” • U.S. economy appears to be expanding at a moderate pace with unemployment falling • U.K and Canada are also growing above their normal rates of expansion
Current Global Situation V • Most of the current concern is with the Eurozone. • With inflation falling close to zero, demand in the region • Appears insufficient to bring down an 11.5% unemployment rate • May not prevent bloc from sliding into deflation • The loss in economic momentum may: • Dampen private investment and • Heightened geopolitical risks – populist governments that have a further negative impact on business and consumer confidence. • In Japan early optimism over Abenomics – economic policies of the prime-minister is now • Tempered with the fear that rising taxes are a major drag on growth • Facing the need for major, but politically unpopular structural reforms – resulting in questions over whether Japan would continue on its path
Current Global Situation VI • In today’s global economy • No longer the advanced world that is most important for global trends • Fully 30 percent of global growth in 2014 will occur in China – about twice the share of the U.S. • Clearly the success of China’s economy is now vital for the rest of the world. However there are problems. • For the medium-term, there is not much evidence that the Chinese economy has made much progress in its critical rebalancing efforts • In the short-term, are fears of a housing crash and bank failures • Housing prices have dropped 9.3% over the last year with • Sales registering the deepest contraction since 2008 • Moody’s estimates that a 10% fall in both property transactions and prices would reduce growth by 1.5% to 2% bringing it to 5 or 6%
Current Global Situation VII • At October 2014 Conference, even the IMF showing increased pessimism • The IMF feels there are many emerging concerns: • Geopolitical tensions from the Middle East and Russia could • “trigger large spillovers of activity in other parts of the world through a renewed bout of increased risk aversion in global financial markets.” • The Fund has just downgraded many of their forecasts • Big question is why countries are struggling to sustain decent rates of growth • Much has to do with remaining hangover from the financial crisis.
Current Global Situation VIII • Factors continuing to limit the return to growth and job creation • High levels of public and private debt act as constraints on • Government fiscal policy and • Consumer spending • Work to suppress aggregate demand below levels needed for steady growth • Increased income inequality also tends to reduce consumer spending • Policy uncertainty in many countries has resulted in falling investment rates • Slowing world economy makes export-led growth more difficult • Situation made worse by signs that productivity growth is slowing, limiting the potential for sustainable growth revival
Current Global Situation IX • In the emerging economies • Growth has slowed from 7% per year before the crisis • To a forecast of 5% between 2014 and 2018 • Moreover the decline is not just due to the slowdown in China and India • Growth rates are now lower than pre-crisis average in 70% of emerging economies. • The slowdown in emerging economies is due to: • The prolonged weakness of high income economies, • Failure to sustain economic reforms and • The exhaustion of policy induced post-crisis boosts to domestic demand. • Still do not expect a major emerging economy crisis
Current Global Situation XI • Policy makers are in a bind in many countries • In the Eurozone and Japan they are still trying to find ways to stimulate demand • In the U.S. and U.K interest rates are about to increase, but there is widespread concern that any movement back to normal might trigger financial turmoil • However leaving monetary policy loose will encourage excessive borrowing which may create bubbles and another financial crash • In emerging markets the need is to push forward on structural reforms to labor and product markets as well as education and social security to enable more secure and rapid growth • Not easy and mistakes are certain to happen. • The economic environment in many parts of the world is thus quite fragile with forecasts increasingly pessimistic.
The New Normal I • The current situation has been called “The New Normal” -It is characterized by: • Deficient Demand – hard to generate enough demand to absorb potential global supply – threat of deflation • Stagnant Productivity. In advanced countries productivity fallen from 2% a year to less than 1% • Fragile Finance – system may be even more fragile than before the crisis. Assets to equity very high making banks vulnerable • Unstable Politics – political stresses – hostility towards elites, foreigners, international institutions make finding solutions difficult • Tense Geopolitics – Russia, China, ISIS, Iran, Ukraine – create great uncertainty • Challenge Overload – both domestic and international. Breakdown of global governance when problems mounting – maintain open global economy, climate change, peace.
Global Scenarios 2015 Three main scenarios: • Baseline-Fragile, Divergent Muddle-Through Recovery (75%) • Output gaps continue to close in U.S. Japan, Germany and the UK, and low growth “New Mediocre” continues • EMs grow below pre-crisis pace and few outperform. • Inflation is controlled, deflation is avoided, “normalization” is slow • Upside – Growth Acceleration (10%) • Above potential growth in most DMs, spurred by pro-business policies, investment, productivity and wage growth • EM reforms support sustainable growth including in China • Inflation is moderate as central banks raise interest rates • Downside-Negative Feedback and Outflows (15%) • A sharp China slowdown and EM currency or financial crisis • Possible EU/Eurozone stress, U.S. policy mistakes, major wars and oil/trade disruption
Assessment of Key Risks • The current consensus forecasts and scenarios are sensitive to a series of possible shocks/adverse developments. • Adverse developments in one or more areas might result in increased instability and/or negative linkages leading to lower growth rates: • Eurozone Crisis • Instability from Oil Price Decline • African Debt Problems • China Hard Landing • Declining Defense Expenditures in the West
Key Risk I: Eurozone Crisis I • The current crisis in the Euro-zone can be easily traced back to a fundamental flaw in the Zone’s economic model: • The model concentrated monetary policy in the European Central Bank (ECB) while leaving fiscal policy to individual member states – inherently unstable arrangement • It denies member states monetary policy levers with which to help their recoveries • Also makes deficit-funded stimulus harder as monetary policy can be used to keep borrowing costs low. • The EZ is not an optimal currency area – the common monetary authority is likely to act in ways that help some countries but not others. • The ECB has pursued tight monetary policy that may prevent inflation in high-growth states like Germany but could also be worsening the recession in Greece, Spain and other struggling states. • Rigid labor markets prevent adjustments common in the United States. • Also Europe still lacks key elements necessary for a common currency to work – Joint European Bank Regulator and a system for dealing with troubled financial institutions, unconstrained independent, central bank
Key Risk I: Eurozone Crisis II • In Europe much of current stability is due to • The pledge of the European Central Bank (ECB) to defend the euro “at any cost” • New financial instruments to defuse debt, and • The start of a banking union • However fiscal adjustment remains unsupportive; unemployment is high in the core economies and continues to increase in Southern Europe • The ECB is under increasing pressures to move toward US-style large-scale bond purchases – controversial whether this will make any difference • At the national level, many of the troubled countries have the option of cutting spending or not cutting – both with major downsides.
Key Risk I: Eurozone Crisis V 1. Cut spending – pretty sure to deepen the recession • Probably means more unemployment (already well over 20% in Spain) • May push wages down to more competitive levels – history suggests this is very hard to do. • Even so, lower wages will just make people’s debts even harder to repay • Meaning they are likely to cut their own spending even more, or stop repaying their debts • Lower wages may not even lead to a quick rise in exports if other European economies markets are in a recession too • In any case, can probably expect more strikes and protests and more nervousness in financial markets (causing even higher interest rates) about whether you really will stay in the euro
Key Risk I: Eurozone Crisis VI 2. Don’t cut spending • Risks a financial collapse • Amount borrowed each year has exploded since 2008 due to economic stagnation and high unemployment • But if economies are chronically uncompetitive within the euro • Markets liable to lose confidence in you – may fear that economies simply too weak to support increasing debt load • Meanwhile other European governments may not have enough money to bail you out, or are legally/politically constrained from doing so • European central bank has said its mandate doesn’t allow it to provide unlimited bond purchases • Clearly only way out of crisis is a coordinated approach involving creditors and debtors and international institutions such as the IMF
Countries at Risk: Greece I Strengths (+) and weaknesses (-) • (+) Euro area membership • European financial assistance has protected the country against a chaotic government default. • (-) High public debt • A history of weak fiscal discipline, combined with the long economic contraction since 2008, has resulted in a very high gross public debt ratio of 177% of GDP in 2013. • (-) Weak competitiveness • Rising labor costs in the years ahead of the crisis have resulted in a weak export growth in recent years. • (-) Poor institutional quality • Greece is lagging other European countries in several indices of institutional strength, like the rule of law, ease of doing business and the corruption index.
Countries at Risk: Greece II • Developments since the Greek elections, Fall 2014 • The recovery that Greece was experiencing last year has ground to a halt, and • Turned into what is very likely a new recession. • The rhetoric out of Athens and the confrontation with its European partners has • Scared the private sector, and • Triggered a massive capital outflow. • Greece has decoupled from the recent improvement in euro area activity, • Indicated by the divergent evolution of the Purchasing Managers Index (PMI) brought on by uncertainty • This is weakening the Greek bargaining position • Eurozone finance ministers unlikely to blink • There is a 30% risk of a catastrophic Grexit.
